The entrance of more retailers such as T-Mobile into the prepaid debit card market could entice more retailers to launch their own cards and more banks to back them.
Behind every prepaid card is a bank that routes transactions and holds deposits in exchange for fee income. A handful of regional banks have dominated this niche market, but as the industry grows, more institutions could latch onto the service to offset diminishing revenue.
Gaining a foothold as a sponsor, however, entails a level of management and regulatory compliance that few banks can handle or afford. And as government agencies crack down on banks for failing to oversee their third-party partners, the risks of the business could outweigh the rewards.
“There’s great demand for bank sponsors,” said Karen L. Garrett, a partner in the banking and financial services division of Stinson Leonard Street. “But it’s not something to be done without an enormous investment into the infrastructure to manage the whole thing.”
Still, in the age of the Dodd-Frank financial overhaul, banks have become adept at dealing with regulation and are better equipped to comply with government demands than other financial institutions are, said Greg McBride, senior financial analyst at Bankrate.com.
Banks back a variety of prepaid products, including ones used for general purchases, corporate payroll and government tax refunds or benefits. Prepaid card sponsors make money off deposits, the charges consumers incur for using the card and interchange — the fees merchants pay when people purchase goods with plastic.
“Our goal is to balance our portfolio,” said John Barbella, senior vice president at Bancorp Bank, which sponsors the Visa prepaid card that T-Mobile introduced on Wednesday. “With benefit cards, there are significant dollars being spent at much lower margins. General purpose products might be a bit more profitable on the front end, but it’s difficult to retain those consumers because often there’s not a consistent stream of income tied to the card.”
Barbella said the industry has benefited from an explosion in the use of prepaid cards since the credit crisis. Consumers made 2.78 billion prepaid Visa and MasterCard transactions totaling $99.5 billion in 2012, up 19 percent from the prior year, according to the most recent data from Nilson Report, a trade publication.
Bancorp Bank is the largest prepaid sponsor, with nearly 25 percent of the market share, according to Nilson.
The firm, along with its main competitor MetaBank, has held top rank in the sponsorship business during continued consolidation. As government regulators raise concerns about safeguards and fees tied to benefit and payroll cards, some banks have exited the market.
Earlier this month, JPMorgan Chase said it planned to stop issuing prepaid cards for corporations and the government, in light of a New York state probe into the fees workers encounter for using the cards.
“The barriers to entry are so much more significant now than they were eight or 10 years ago,” Barbella said. Banks have to ask themselves: “Can you really afford to comply at the levels required when you don’t have a portfolio in place to generate the revenues to offset that expense?”
McBride contends that regulatory and reputation risk are a part of the calculation in every service that banks offer, and the growth opportunities in sponsorship may be enough to offset that gamble.
“Payment transactions have been an area that banks have identified as a potential for revenue stream where if they’re not careful,” they can be pushed out of the business altogether, he said. “They understand the risks.”
There is more than one avenue for banks to participate in the prepaid market, McBride said, noting that more banks are offering their own cards to existing customers and people who might not qualify for a checking account.
About a dozen of the country’s largest banks, including JPMorgan and PNC Bank, offer their own prepaid cards. It is unclear how much banks are making from these cards, as they don’t break out the revenue in their earnings. But the cards are attractive because they are exempt from an amendment in Dodd-Frank that restricts the amount banks can earn from debit and credit card fees.